On Sept. 1, the U.S. Department of the Treasury and the IRS issued Notice 2020-69, which notifies taxpayers that regulations will be published to allow certain subchapter S corporations to elect to be treated as entities for purposes of the global intangible low-taxed income (GILTI) under Section 951A. This entity treatment will provide shareholders of eligible S corporations with relief from potential double taxation that results under the final GILTI regulations published in 2019. The notice also provides that S corporations don’t have to wait for regulations to be published to take advantage of the new rules.
Under the 2019 GILTI regulations, S corporations are treated as foreign partnerships, which means S corporations must use the aggregate method for taking into account GILTI attributes and allocate those attributes to the S-corporation shareholders rather than computing a GILTI inclusion at the entity level and distributing the inclusion to its shareholders. Under the aggregate method, GILTI is not an item of income to the S corporation that is distributed to its shareholders. Instead, the S corporation allocates each shareholder a pro rata share of GILTI attributes (such as tested income, qualified business asset investment, tested interest income, and expense), which the shareholder then uses to compute its own GILTI inclusion.
Because the S corporation does not have an entity-level income event with respect to items allocated under the aggregate method, the S corporation does not increase its accumulated adjustments account (AAA). This could result in double taxation to the S-corporation shareholders in certain situations. For instance, when an S corporation makes a distribution to its shareholders to pay taxes that arise from taking into account the GILTI attributes, that distribution is tax free up to the amount of AAA, limited by basis. If there is no AAA and the S corporation has accumulated earnings and profits (AE&P) as a result of previously being a C corporation, the distribution is considered as coming out of AE&P and is taxable as a dividend. Therefore, if an S corporation with AE&P that has exhausted its AAA makes a distribution to its shareholders to pay their tax on their GILTI inclusions that arose from attributes passed through the S corporation, its shareholders are subject to additional tax on earnings that already have been subject to tax.